Heritage Commerce Corp Reports Earnings of $11.2 Million for the Third Quarter of 2020

SAN JOSE, Calif., Oct. 22, 2020 (GLOBE NEWSWIRE) -- Heritage Commerce Corp (Nasdaq: HTBK) , the holding company (the Company) for Heritage Bank of Commerce (the Bank), today announced third quarter 2020 net income of $11.2 million, or $0.19 per average diluted common share, compared to $11.3 million, or $0.26 per average diluted common share, for the third quarter of 2019, and $10.6 million, or $0.18 per average diluted common share, for the second quarter of 2020.  For the nine months ended September 30, 2020, net income was $23.7 million, or $0.39 per average diluted common share, compared to $34.8 million, or $0.80 per average diluted common share, for the nine months ended September 30, 2019. All results are unaudited.

We delivered solid earnings in the third quarter of 2020 against the backdrop of an economy affected by the Coronavirus pandemic, said Keith A. Wilton, President and Chief Executive Officer.  In the face of these challenges, we continued to work diligently to support our customers, communities and employees while prudently managing risk.  Our participation in the Small Business Administration (SBA) Paycheck Protection Program (PPP) in the prior quarters helped us in this capacity.  Loan and deposit trends remained steady and our noninterest income increased by 25% from the preceding quarter, primarily due to a $400,000 gain on sale of SBA loans and a $310,000 gain realized on a warrant that we exercised.  As anticipated, our net interest margin contracted during the quarter following the 150 basis point rate reduction by the Federal Reserve Bank earlier in the year and the low interest rates on recently funded SBA PPP loans.

Credit quality metrics remained stable, and we are particularly encouraged by the fact that of the $186.6 million of initial COVID-19 related loan deferrals, $145.3 million have resumed payments as of September 30, 2020, said Mr. Wilton. Of the loans remaining in deferment, most are backed by some form of real estate or personal guarantees.  As well, the provision for credit losses was a modest $197,000 for the third quarter of 2020. The allowance for credit losses on loans (ACLL) to total loans was 1.68%, and the ACLL to total loans, excluding PPP loans, was 1.91% at September 30, 2020.

Our regulatory capital position held relatively steady and remained healthy at the end of the third quarter of 2020. Our capital base serves as the foundation of the Banks financial condition and the basis of security for our banking customers, stated Mr. Wilton.  Total risk-based capital ratio and leverage ratio for the Company (consolidated) was 16.0% and 9.3%, respectively, and 15.2% and 9.7%, respectively, for the Bank, at September 30, 2020.

As previously announced, in the third quarter of 2020, we relocated our corporate headquarters, San Jose Branch and factoring subsidiary, Bay View Funding, to 224 Airport Parkway, San Jose, CA, commented Mr. Wilton.  This new facility allows us to cost effectively consolidate many of the Banks dispersed operating units into a single location to better support our customers, community partners and the entire Heritage organization.

Coronavirus (COVID-19) Weighs on Local Communities and Our Economy

The overall impact of the pandemic on our local economy and communities continues to be felt.  In our seven county Bay Area market, 331,000 jobs (9.2%) have been lost since the end of February 2020. The unemployment rate in the seven Bay Area counties we serve fell to 8.1% in September, down from 12.8% in April, but still higher than the 2.7% in February 2020. 

We continue to monitor all state and local developments and have taken a number of steps to protect our employees and support our customers impacted by COVID-19, added Mr. Wilton. Based on our strong capital position, diversified loan portfolio, conservative underwriting standards, liquidity position, and our dedicated team of outstanding employees, we believe we will be able to continue to successfully navigate through these uncertain times and emerge stronger from the current crisis.

In response to two economic stimulus laws passed by Congress in the first half of the year, Heritage Bank of Commerce funded 1,105 PPP loans, with total principal balances of $333.4 million.  During the second and third quarters of 2020, PPP loan pay offs totaled $9.8 million and the Bank ended the third quarter of 2020 with $323.6 million in outstanding PPP loan balances.  These loans generated $1.4 million in interest income and $2.2 million in deferred fee income, which were partially offset by ($245,000) in deferred costs expensed during the second and third quarters of 2020.  At September 30, 2020, total loans included deferred fees on PPP loans of $9.0 million and deferred costs of $995,000. 

In accordance with new accounting guidance issued earlier this year by federal bank regulators, the Bank made accommodations for initial payment deferrals for a number of customers of up to 90 days, generally, with the potential, upon application, of an additional 90 days of payment deferral (180 days maximum). The Bank also waived all normal applicable fees. The following table shows the deferments at September 30, 2020 by category:

The Bank had elected to initially downgrade the risk grades of these loans to Special Mention status and upon return to regular monthly payment status, most have now been upgraded back to Pass.  At the end of the third quarter of 2020, the pool of deferred loans in our portfolio were mostly tied to business borrowers from a broad range of industries and included $2.0 million in loan deferments to the healthcare industry and $7.8 million in loan deferments to the accommodation and food services industries (mostly hotels and restaurants).   Of the $41.4 million of loans remaining in deferral, 89% are supported by some form of commercial or residential real estate. Commercial real estate (CRE) deferments of $24.2 million included $19.6 million of investor CRE and $4.6 million of owner-occupied CRE. Deferred loans secured by CRE had an average loan-to-value (LTV) ratio of 44.5% at the end of the third quarter of 2020.  There was also $12.6 million of deferments on residential real estate, primarily home equity lines, as of September 30, 2020.  The majority of deferred loans are also supported by personal guarantees.   

In addition to its portfolio of SBA PPP loans, the Bank also has a portfolio of SBA 7(a) loans totaling $49.6 million as of October 16, 2020.  As part of the SBAs Coronavirus debt relief efforts, beginning in April of 2020, the SBA commenced a six-month program to cover payments of principal, interest and any associated fees for these borrowers, which largely ended with the September payment. The following table reflects the status of these SBA 7(a) loans as of October 16, 2020:

Credit Quality and Performance

At September 30, 2020, nonperforming assets (NPAs) declined by $3.9 million, or (28%), to $10.3 million, compared to $14.2 million at September 30, 2019, and increased by $1.2 million, or 12% from $9.1 million at June 30, 2020.  Classified assets increased to $33.0 million, or 0.72% of total assets, at September 30, 2020, compared to $20.2 million, or 0.64% of total assets, at September 30, 2019, and $31.5 million, or 0.68% of total assets, at June 30, 2020.

The Company continues to monitor portfolio loans made to commercial customers with businesses in higher risk sectors due to the COVID-19 pandemic. During the third quarter of 2020, the percentage of loans identified as higher risk to total loans declined slightly compared to the second quarter of 2020. The following table provides a breakdown of such loans as a percentage of total loans at September 30, 2020, June 30, 2020, and March 31, 2020:

The increase in higher risk sectors in the second and third quarters, compared to the first quarter of 2020, was primarily due to the addition of PPP loans during the second quarter of 2020. 

Capital and Liquidity

The Companys and the Banks consolidated capital ratios exceeded regulatory guidelines for a well-capitalized financial institution, and the Basel III minimum regulatory requirements at September 30, 2020.

Our liquidity position refers to our ability to maintain cash flows sufficient to fund operations, meet all of our obligations and commitments, and accommodate unexpected sudden changes in balances of loans and deposits in a timely manner. At September 30, 2020, the Company had a strong liquidity position with $960.3 million in cash and cash equivalents, and approximately $734.8 million in available borrowing capacity from sources including the Federal Home Loan Bank (FHLB), the Federal Reserve Bank of San Francisco (FRB), Federal funds facilities with several financial institutions, and a line of credit with a correspondent bank. The Company also had $557.8 million (at fair market value) in unpledged securities available at September 30, 2020. The loan to deposit ratio remained relatively flat at 69.32 % at September 30, 2020, compared to 69.74% at September 30, 2019, and increased from 68.88% at June 30, 2020. 

Third Quarter and First Nine Months of 2020  
Operating Results, Balance Sheet Review, Capital Management, and Credit Quality
(as of, or for the periods ended September 30, 2020, compared to September 30, 2019, and June 30, 2020, except as noted):

Operating Results:

• Diluted earnings per share were $0.19 for the third quarter of 2020, compared to $0.26 for the third quarter of 2019, and $0.18 for the second quarter of 2020. Diluted earnings per share were $0.39 for the first nine months of 2020, compared to $0.80 for the first nine months of 2019.
  
  

• The following table indicates the ratios for the return on average tangible assets and the return on average tangible equity for the periods indicated:

• Net interest income, before provision for credit losses on loans, increased 12% to $34.2 million for the third quarter of 2020, compared to $30.6 million for the third quarter of 2019, primarily due to an increase in the average balance of loans resulting from the Presidio Bank (Presidio) merger, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio during the fourth quarter of 2019, partially offset by decreases in the prime interest rate and decreases in the yield on investment securities and overnight funds.  Net interest income for the third quarter of 2020 decreased (2%) from $34.9 million for the second quarter of 2020, primarily due to decreases in the yields on loans, investment securities and overnight funds, partially offset by additional interest and fee income from PPP loans. Net interest income increased 16% to $107.7 million for the first nine months of 2020, compared to $92.6 million for the first nine months of 2019, primarily due to an increase in the average balance of loans resulting from the Presidio merger, additional interest and fee income from PPP loans, and an increase in the accretion of the loan discount into loan interest income from our merger with Presidio, partially offset by decreases in the prime rate, and decreases in the yield on investment securities and overnight funds.
  
  

  • The fully tax equivalent (FTE) net interest margin contracted 100 basis points to 3.24% for the third quarter of 2020, from 4.24% for the third quarter of 2019, primarily due to a decline in the average yield of loans, investment securities, and overnight funds, partially offset by a decline in the cost of interest-bearing liabilities.  The FTE net interest margin contracted 22 basis points for the third quarter of 2020 from 3.46% for the second quarter of 2020, primarily due to a decline in the average yield on loans, investment securities, and overnight funds, partially offset by a decline in the cost of interest-bearing liabilities.
    
    

  • For the first nine months of 2020, the FTE net interest margin contracted 71 basis points to 3.62%, compared to 4.33% for the first nine months of 2019, primarily due to the impact of decreases in the yields on loans, investment securities, and overnight funds, partially offset by a decline in the cost of interest-bearing liabilities.

• The following tables present the average balance of loans outstanding, interest income, and the average yield for the periods indicated:
  
  

  • The average yield on the total loan portfolio decreased to 4.86% for the third quarter of 2020, compared to 5.83% for the third quarter of 2019, primarily due to a decline in the average yield on loans and new average balances of lower yielding PPP loans, partially offset by an increase in the accretion of the loan purchase discount into loan interest income from the acquisitions.

• The average yield on the total loan portfolio decreased to 4.86% for the third quarter of 2020 compared to 4.92% for the second quarter of 2020, primarily due to higher average balances of lower yielding PPP loans, partially offset by an increase in the accretion of the loan purchase discount into loan interest income from the acquisitions.

• The average yield on the total loan portfolio decreased to 5.10% for the nine months ended September 30, 2020 compared to 5.90% for the nine months ended September 30, 2019, primarily due to decreases in the prime rate on loans and new average balances of lower yielding PPP loans, partially offset an increase in the accretion of the loan purchase discount into loan interest income from the acquisitions.

• The total net purchase discount on loans from the Focus Business Bank loan portfolio was $5.4 million on the acquisition date of August 20, 2015, of which $339,000 remains outstanding as of September 30, 2020.  The total net purchase discount on loans from the Tri-Valley Bank loan portfolio was $2.6 million on the acquisition date of April 6, 2018, of which $1.1 million remains outstanding as of September 30, 2020.  The total net purchase discount on loans from the United American Bank loan portfolio was $4.7 million on the acquisition date of May 4, 2018, of which $1.8 million remains outstanding as of September 30, 2020.  The total net purchase discount on loans from the Presidio loan portfolio was $12.5 million on the Presidio merger date of October 11, 2019, of which $9.5 million remains outstanding as of September 30, 2020.  In aggregate, the remaining net purchase discount on total loans acquired was $12.8 million at September 30, 2020.

" The average cost of total deposits was 0.16% for the third quarter of 2020, compared to 0.31% for the third quarter of 2019 and 0.17% for the second quarter of 2020. The average cost of total deposits was 0.18% for the nine months ended September 30, 2020, compared to 0.30% for the nine months ended September 30, 2019.  

" There was a $197,000 provision for credit losses on loans for the third quarter of 2020, compared to a credit to the provision for loan losses of ($576,000) for the third quarter of 2019, and a $1.1 million provision for credit losses on loans for the second quarter of 2020.  There was a $14.6 million provision for credit losses on loans for the nine months ended September 30, 2020, compared to a ($2.4) million credit to the provision for loan losses for the nine months ended September 30, 2019. 

" The increase in the provision for credit losses on loans for the nine months ended September 30, 2020, compared to the nine months ended September 30, 2019, was driven primarily by a significantly deteriorated economic outlook resulting from the Coronavirus pandemic.  Most major economic forecasts, including the California Economic Forecast (CEF) used by the Bank in its current expected credit losses (CECL) Model, show a significant decline in California GDP and a substantial rise in unemployment for 2020.  At January 1, 2020, the forecast for California GDP for 2020 was an annual increase in the low single digits and the forecasted California unemployment rate for 2020 was in the mid-single digits.  In September 2020, the CEF forecast was revised for GDP in the negative low single digits and peak unemployment in the low double digits.  The three loan classes where the largest increases in reserves were recorded under the CECL loss rate methodology were investor-owned CRE, construction & land, and commercial and industrial (C&I).  Ongoing impacts of the CECL methodology will be dependent upon changes in economic conditions and forecasts, originated and acquired loan portfolio composition, portfolio duration, and other factors.

" Total noninterest income remained relatively flat at $2.6 million for the third quarter of 2020, compared to the third quarter of 2019, as lower services charges and fees on deposit accounts were mostly offset by a higher gain on sales of SBA loans and a realized gain on warrants exercised during the third quarter of 2020.  Total noninterest income increased for the third quarter of 2020 from $2.1 million for the second quarter of 2020, primarily due to a $400,000 gain on sales of SBA loans, and a $310,000 realized gain on warrants exercised.

• For the nine months ended September 30, 2020, total noninterest income remained relatively flat from $7.9 million for the nine months ended September 30, 2019, as lower services charges and fees on deposit accounts were mostly offset by a higher increase in the cash surrender value of life insurance, a gain realized on a warrant exercised, and a gain on the disposition of foreclosed assets during the first nine months of 2020.

" Total noninterest expense for the third quarter of 2020 increased to $21.2 million, compared to $17.9 million for the third quarter of 2019, primarily due to additional employees and operating costs as a result of the Presidio merger, and higher salaries and employee benefits as a result of annual salary increases. Total noninterest expense for the third quarter of 2020 modestly increased to $21.2 million compared to $21.0 million for the second quarter of 2020.

• Noninterest expense for the nine months ended September 30, 2020 increased to $68.0 million, compared to $54.3 million for the nine months ended September 30, 2019, primarily due to higher salaries and employee benefits as a result of annual salary increases, and additional employees and operating costs added as a result of the Presidio merger.
  
  

• The following table reflects pre-tax merger-related costs related to the merger with Presidio for the periods indicated: 

• Full time equivalent employees were 342 at September 30, 2020, 308 at September 30, 2019, and 340 at June 30, 2020.

" The efficiency ratio was 57.58% for the third quarter of 2020, compared to 53.87% for the third quarter of 2019, and 56.76% for the second quarter of 2020. The efficiency ratio for the nine months ended September 30, 2020 was 58.81%, compared to 54.04% for the nine months ended September 30, 2019. 

" Income tax expense was $4.2 million for the third quarter of 2020, compared to $4.6 million for the third quarter of 2019, and $4.3 million for the second quarter of 2020. The effective tax rate for the third quarter of 2020 was 27.3%, compared to 29.1% for the third quarter of 2019, and 28.7% for the second quarter of 2020.  Income tax expense for the nine months ended September 30, 2020 was $9.3 million, compared to $13.8 million for the nine months ended September 30, 2019. The effective tax rate for the nine months ended September 30, 2020 was 28.3%, compared to 28.4% for the nine months ended September 30, 2019.

• The difference in the effective tax rate for the periods reported compared to the combined Federal and state statutory tax rate of 29.6% is primarily the result of the Companys investment in life insurance policies whose earnings are not subject to taxes, tax credits related to investments in low income housing limited partnerships (net of low income housing investment losses), and tax-exempt interest income earned on municipal bonds.

Balance Sheet Review, Capital Management and Credit Quality:

• Total assets increased 45% to $4.61 billion at September 30, 2020, compared to $3.18 billion at September 30, 2019, primarily due to the Presidio merger and the addition of PPP program. Total assets remained relatively flat from $4.61 billion at June 30, 2020.

• Securities available-for-sale, at fair value, totaled $294.4 million at September 30, 2020, compared to $333.1 million at September 30, 2019, and $323.6 million at June 30, 2020.  At September 30, 2020, the Companys securities available-for-sale portfolio was comprised of $203.6 million of agency mortgage-backed securities (all issued by U.S. Government sponsored entities), and $90.8 million of U.S. Treasury securities. The pre-tax unrealized gain on securities available-for-sale at September 30, 2020 was $6.9 million, compared to a pre-tax unrealized gain on securities available-for-sale of $1.7 million at September 30, 2019, and a pre-tax unrealized gain on securities available-for-sale of $8.7 million at June 30, 2020.  All other factors remaining the same, when market interest rates are decreasing, the Company will experience a higher unrealized gain (or a lower unrealized loss) on the securities portfolio.

• At September 30, 2020, securities held-to-maturity, at amortized cost, totaled $295.6 million, compared to $342.0 million at September 30, 2019, and $322.7 million at June 30, 2020.  At September 30, 2020, the Companys securities held-to-maturity portfolio was comprised of $223.4 million of agency mortgage-backed securities, and $72.2 million of tax-exempt municipal bonds.
  
  

  • With the CECL methodology implementation date of January 1, 2020, there was a $58,000 allowance for losses recorded on the Companys held-to-maturity municipal investment securities portfolio. For the nine months ended September 30, 2020, there was a reduction of $3,000 to the allowance for losses on the Companys held-to-maturity municipal investment securities portfolio, for an allowance for losses of $55,000 at September 30, 2020.

• The loan portfolio remains well-diversified as reflected in the following table which summarizes the distribution of loans, excluding loans held-for-sale, and the percentage of distribution in each category for the periods indicated:

• Loans, excluding loans held-for-sale, increased $821.6 million, or 44%, to $2.70 billion at September 30, 2020, compared to $1.88 billion at September 30, 2019, and remained relatively flat from $2.69 billion at June 30, 2020.  Total loans at September 30, 2020 included $323.6 million of PPP loans.
  
  

• Commercial and Industrial (C&I) line usage was 28% at September 30, 2020, compared to 35% at September 30, 2019, and 27% at June 30, 2020.
  
  

• At September 30, 2020, 44% of the CRE loan portfolio was secured by owner-occupied real estate.

"  The following table summarizes the allowance for credit losses on loans ⁽¹⁾ for the periods indicated:

• The ACLL was 1.68% of total loans at September 30, 2020 and the ACLL to total nonperforming loans was 442.62% at September 30, 2020. The ALLL was 1.38% of total loans and the ALLL to nonperforming loans was 181.76% at September 30, 2019. The ACLL was 1.69% of total loans at June 30, 2020 and the ACLL to total nonperforming loans was 498.02% at June 30, 2020.   The ACLL was 1.91% of total loans, excluding PPP loans, at September 30, 2020, compared to 1.92% at June 30, 2020.
  

• The following table shows the results of adopting CECL for the first nine months of 2020:
  

• Net charge-offs totaled $219,000 for the third quarter of 2020, compared to net charge-offs of $160,000 for the third quarter of 2019, and net charge-offs of $373,000 for the second quarter of 2020.

"  The following is a breakout of NPAs at the periods indicated:

• NPAs totaled $10.3 million, or 0.22% of total assets, at September 30, 2020, compared to $14.2 million, or 0.45% of total assets, at September 30, 2019, and $9.1 million, or 0.20% of total assets, at June 30, 2020.
  
  

• There were no foreclosed assets on the balance sheet at September 30, 2020, September 30, 2019, or June 30, 2020.
  
  

• Classified assets increased to $33.0 million, or 0.72% of total assets, at September 30, 2020, compared to $20.2 million, or 0.64% of total assets, at September 30, 2019, and decreased from $31.5 million, or 0.68% of total assets, at June 30, 2020.

"  The following table summarizes the distribution of deposits and the percentage of distribution in each category for the periods indicated: